Sentiment could turn for worthy small-caps

The last quarter of the financial year has been particularly harsh on small-cap investors, who are left with big wounds to lick.

The S&P/ASX Small Ordinaries index is likely to leave 2011-12 with about a 20 per cent loss compared with a 5 per cent loss on the top 200 stock benchmark.

Most of the underperformance has occurred in the past three months as conditions became especially hostile for the riskier small end of the market.

Don’t expect any reprieve in the short term. The negative sentiment towards emerging stocks is likely to persist into the new year, as investor risk appetite will be suppressed until Europe outlines a viable solution to stem the region’s credit crisis, and confidence in the US and Chinese economies improves.

This could happen in the next quarter or so, and some of the ugliest small-cap dogs of 2011-12 could give the biggest bite, given how far they have fallen.

Picking the right underachiever to back is a high-risk exercise, but it’s interesting to note that a handful of these dogs still enjoy a “buy" recommendation from nearly all brokers that cover the stock.

While this doesn’t mean analysts have their forecasts right – given that they are usually slower than the market in adjusting earnings expectations – investors can seek comfort in the fact there is a fairly large margin of error that appears to be built into current share prices.

The West African goldminer
Gryphon
is among the worst small-cap performers this year, hit by factors beyond its control.

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Most of these appear to be sentiment-driven, with the stock having shed about 60 per cent in the past year and trading close to last month’s two-year low of 61¢.

Global uncertainties have drained investor interest in explorers that are still some way away from production, and worries that the spot gold price will correct sharply are some of the factors dragging on the stock.

Investors have also lost their taste for African-based gold explorers, and the potential delays and cost blowouts in the commissioning of its flagship Banfora gold project are not helping sentiment towards Gryphon Minerals.

But Banfora has excellent potential and is seen as a relatively low-risk endeavour.

Interest in Gryphon could be reawakened by a new gold resource estimate for the project expected over the next few weeks, followed by a definitive feasibility study based on an annual 200,000 ounces of gold production that is scheduled to be released in the September quarter.

Banfora is expected to start production in 2013-14 or 2014-15, and the average broker price target is $1.50.

Emeco Holdings
isn’t one of the ugliest in terms of losses for the year, but the stock has crashed by more than 20 per cent and is hovering uncomfortably close to its 19-month low of 84.5¢, reached a month ago.

A potential slowdown in mining activity due to waning commodity prices is one key reason for the selldown. A legal claim and counter-claim against its Indonesian subsidiary is also weighing on the stock.

But the market doesn’t seem to be appreciating the changes in Emeco’s business, which RBS Morgans says make it a fundamentally better business than before the global financial crisis.

The company has reconfigured its fleet and the business is now 90 per cent exposed to production-based work, compared with less than 75 per cent pre-GFC.

The amount of production work is expected to stay elevated until 2015-16, according to the broker.

The stock is fundamentally cheap on a consensus 2012-13 price-earnings multiple of 6.8 times – a 17 per cent discount to its peers – and is on a fully franked dividend yield close to 8 per cent.

The average broker price target is $1.19 a share.

Weak sentiment towards the residential market and uncertainty about the value of its retirement village assets are some of the factors dragging the stock to its lowest close since the depth of the GFC in March 2009.

Investors appear reluctant to touch the stock as they believe the value of its property portfolio will be written down. By how much is anyone’s guess at the moment, with the stock trading at a 54 per cent discount to its tangible book value. This uncertainty could complicate
FKP
’s efforts to offload its retirement villages.

But the stock is trading at levels that are difficult to justify and JPMorgan is one of the five brokers urging investors to buy the company’s shares as potential corporate interest could spark a re-rating.

Given that FKP is trading on a one-year forward P/E of under four, it doesn’t really need to post earnings growth to hold its value.

The stock is on a consensus forecast yield of about 8 per cent for 2012-13 and the average broker price target is 68¢.